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February 2, 19U3

Chairman Eccles
L. I * Piner

Replacement of maturities

If the Treasury is agreeable to/direct replacement of maturities by
the System, the mechanical arrangements on issues other than bills would be
simple. In the offering circular the Treasury would place the System in the
category of nonbanking investors, whose subscriptions are allotted in full,
rather than in the category of commercial banks. A concurrent public announcement would be made that the purpose of this change was to enable the System to
replaoe maturities, and the amount of the System's holdings of the maturing
issue would be stated. The amount allotted on commercial bank subscriptions
for over $100,000 would be reduced i y the System's subscription as well as by
the bank subscriptions for $100,000 and less and the noribank subscriptions.
The Treasury should also shift the dealers from the full allotment
to the percentage allotment basis for securities available to commercial banks*
In the December financing dealers and brokers subscribed for 361 million dollars
of marketable securities. Of this total 115 million dollars was for 2 l/2 per
cent bonds, which were subsequently sold to nonbanking invsstors. It is likely
that most of the remaining J66 million dollars was sold to commercial banks.
In the recent certificate offering the dealers subscribed for 220 million dollars,
most of which probably went to commercial banks. The profit on this transaction may have amounted to about $250,000. It seems to me that the fact that
commercial banks in both instances bid for securities in addition to their allotments provides a strong argument that excess reserves are still considerably above
the level that is necessary in order to obtain the widest possible distribution
among nonbanking investors.

If the Treasury offers bills at a flat rate of 3/8 of 1 per cent, the
mechanical arrangements for direct replacement of maturities would be similar to
those on other securities. If the Treasury continues to sell bills on a bid
basis, it would be necessary to arrange for the rate at which the System's
replacements would be made. A rate of 3/8 of 1 ?*** cent would result in criticism
that the System was being given a preferential rate over other investors. The
average rate at which other bids were accepted probably would be the most satisfactory basis. In the announcement of the new offering on each Friday the Treasury
would state tha amount of th« System's holdings as of the previous Wednesday. The
amount allotted to the public would be reduced by the System's subscription.
Some argunients may be presented for replacing all, part, or none of each
maturity depending on circumstances. The demand for new issues fluctuates widely
from time to time. The System's holdings of each issue vary widely and may have
no relation to the demand for new issues. There would be some advantage in
relating the amount of each replacement to the current investor demand rather than
to the amount of maturities that the System happens to hold. On the other hand,


Chainsan Eccles

m* 2 mm

it would be difficult to estimate in advance the demand for each new issue.
Each member of the executive committee might well have a different idea as to
the amount, and time would be consumed in deciding the question on each issue*
Perhaps the best solution would be to replace maturities in full and to sell
freely from the System's holdings if a demand develops as well as to buy freely
if the new issues are in supply.
Under the recent opinions by Mr. Wyatt and Mr. Dreibelbis the replacement of maturing certificates is considered to be an exchange and not a direct
purchase. It is ay understanding that the replacement of maturing bills would
also be considered as an exchange if the Federal Reserve tenders
the maturing
bills in payment for the new bills. This interpretation would not be affected
by the fact that the exchange is not of par for par and would involve a payment
by the Treasury to the federal Reserve.
The question of giving rights on certificates raises the old arguments
for and against rights that were discussed a year or more ago. Rights do give
the long-term investor a preferred position in replacing rmturities and probably
encourage the holding of issues until maturity. On the other hand, they encourage
speculation on the basis of the price of the new issue and enable dealers and
other traders to make an unreasonable profit out of Treasury financing.